LLC or sole proprietor: which fits a new contracting business?

Most new service owners face this choice in their first week, usually with a friend telling them one thing and a website selling LLC filings telling them another. The decision is simpler than it looks. It comes down to how much personal risk you carry, how much paperwork you will tolerate, and what your state charges. Here is how the two compare, based on what the IRS and SBA publish. Rules on formation, fees and liability are set by each state, so read this as background and confirm the details with an accountant or attorney who practices where you work. Treat it as general information, not as legal or tax advice for your situation.

What is the difference between an LLC and a sole proprietorship?

A sole proprietorship is not a separate entity at all. It is you, doing business. If you work under your own legal name, the SBA says you will not need to register anywhere. You may still need licenses and permits, which the SBA says depend on your business activities and location. The tradeoff is liability: the SBA's structure guide warns that sole proprietors carry personal liability for what the business owes and the obligations it takes on.

A limited liability company is a separate legal entity created by filing with your state. The same SBA page says an LLC protects you from personal liability "in most instances," so that your vehicle, house and savings are not at risk for the company's debts. You pay a state filing fee, may have to file an annual or biennial report depending on your state, and keep the company's money apart from yours.

Do LLCs pay less tax than sole proprietors?

Not by default. The IRS explains that "an LLC with only one member is treated as an entity disregarded as separate from its owner" for income tax unless it elects otherwise. In practice, a single-member LLC and a sole proprietorship report the same profit on the same personal return, and the IRS says the owner of a single-member LLC owes self-employment tax in the same manner as a sole proprietor. The IRS puts that rate at 12.4% for Social Security plus 2.9% for Medicare, generally once net earnings hit $400.

Two wrinkles matter. First, the IRS says a single-member LLC is still treated as a separate entity for employment taxes and certain excise taxes, so an LLC with employees reports payroll taxes under its own name and EIN. The IRS adds that most new single-member LLCs will need an EIN, while one that has neither employees nor an excise tax liability does not. Second, an LLC can file Form 8832 to be taxed as a corporation, or Form 2553 to elect S corporation status. Owners sometimes do this once profit is steady, because of how S corporation owners split pay between salary and distributions. Whether it saves you money depends on your profit, your state and the cost of running payroll for yourself. That calculation belongs to an accountant, not a blog.

A multi-member LLC (you and a partner) is taxed as a partnership by default, which means a separate partnership return. If you are starting with a partner, get professional help on the operating agreement and the tax setup before you file.

What does an LLC actually protect, and what doesn't it?

The point of the LLC is to separate the company's debts from your personal ones. If the business owes a supplier or loses a contract dispute, the creditor generally goes after the company's assets, not your house. That protection is worth something real in trades where you work on other people's property with expensive equipment.

It has limits, and they are worth understanding before you assume the paperwork protects you:

• Personal guarantees. Banks, equipment dealers and landlords often ask a new LLC's owner to sign personally. Once you sign, that debt is yours regardless of the LLC.
• Mixing money. The SBA notes that a separate business bank account supports your limited liability. Paying the mortgage from the company card weakens the separation you paid to create.
• Your own conduct. Ask an attorney how your state treats claims against an owner for their own actions on a job. The answer shapes how much insurance you need.
• Insurance still pays the claim. An LLC can limit what a lawsuit reaches. General liability insurance is what pays for the damaged deck or the injured visitor. Our insurance guide covers the policies most trades carry.

How much paperwork does an LLC add?

Less than people fear. Forming one usually means a filing with your state's business office (often the secretary of state), a registered agent in that state, which the SBA says you need before you file, and an operating agreement you keep on file. The SBA's registration guidance says the total cost to register is less than $300 in most cases, though fees vary by state and structure, and some states add a recurring report fee. Look up your own state's fee schedule before you decide.

After formation, the recurring work is light: file the annual report on time, keep the registered agent current, keep the bank account separate, and sign contracts in the company's name ("Example Co. LLC, by Jane Owner, Member") rather than your own. Missing a report has real consequences in some states. Florida, for example, charges LLCs a $400 late fee for reports filed after May 1 and administratively dissolves companies whose report still isn't filed by the third Friday of September, though they can apply for reinstatement. Ask your attorney what a lapse would mean for your protection in your state.

Sequence matters if you go the LLC route: the state approves the company first, then you apply for the EIN, then you open the bank account, since a bank may ask for both. The IRS says applying before the entity exists can delay your EIN. Our EIN guide walks through the IRS application itself.

Which should a new contractor choose?

There is no universal answer, but patterns show up across trades:

• Starting part-time, low risk, own name: many owners begin as sole proprietors to test demand, then form an LLC once the work is steady. Insure from day one either way.
• Working on homes with expensive equipment or chemicals: if your crew runs pressure equipment, ladders, chemicals or saws on other people's property, ask your advisor about forming an LLC early, alongside proper insurance.
• Planning to hire: employees bring payroll, workers' compensation and more exposure, and the IRS says you need an EIN to hire. Many owners put the LLC in place before the first hire so payroll starts under the right name.
• Selling to commercial clients: property managers and general contractors commonly ask for a W-9 and a certificate of insurance before they onboard a vendor, and some prefer to work with a registered entity.

Whichever you pick, the back-office setup is identical: a business bank account, a business phone number, email on your own domain, a website, a Google Business Profile in the company's legal or trade name, and a CRM where customers and invoices live. Make sure the name on all of them matches the name you register, because mismatched names confuse customers and search engines alike. Our startup checklist lists each step in order.

Can you switch from sole proprietor to LLC later?

Yes, and plenty of owners do. You form the LLC with the state, get a new EIN for it if needed, open a new bank account in its name, and move contracts, insurance and accounts over. The IRS lists a change in business structure as one of the reasons you may need an EIN.

The part people forget is everything customer-facing. Update the legal name on your website footer, your quotes and invoices, your payment processor, your Business Profile if the name changes, and your certificates of insurance. If your trade name stays the same, customers will barely notice, which is a good argument for picking a trade name you can keep through the switch. When the systems that hold your customers (phone number, domain, CRM) are already in the business's name, the move is far simpler.

We set those systems up so they move with you. If you are starting fresh, our start a company hub lists our other startup guides, and a free system quote will check whether your phone, website and profile are set up in a way that survives a change of structure.

Frequently asked questions